Things haven’t been easy for America’s largest grocery store operator. Kroger Co (NYSE:KR), the owner of its namesake Kroger, as well as Ralph’s, Dillon’s, Fry’s and many more, has seen its stock fall nearly 40% so far in 2017. The culprit? Even bigger retailers, who are now branching into the grocery world.
The culprit? Even bigger retailers, who are now branching into the grocery world.
Big box discount retailers like Wal-Mart Stores Inc (NYSE:WMT) and Target Corporation (NYSE:TGT) are really pushing their own grocery offerings. Meanwhile, e-commerce giant Amazon.com, Inc. (NASDAQ:AMZN) recently acquired Whole Foods Market, Inc. (NASDAQ:WFM) and is cutting prices across the board.
Put it all together, and it’s easy to see why grocery stocks are down big in 2017. The grocery space is starting to look a lot like mall retail. Technology is changing everything. The price backdrop is persistently promotional. Margins are in free fall. Traditional players are getting squeezed by new entrants.
So it shouldn’t be any big surprise that KR stock is taking another leg lower today after the company reported mixed quarterly results. Revenue came in slightly better than expected. Kroger has enough scale to offset near-term pressures on its top line. But earnings missed expectations and profits fell year-over-year. Clearly, the promotional pricing backdrop is making it tough for Kroger grow profits.
The big kicker in the report was that Kroger management has decided to stop providing long-term guidance given the dynamic changes in the grocery space.
That is huge. This is a company that has stated again and again that they are “committed to achieving a net earnings per diluted share growth rate of 8% to 11%, plus a growing dividend”. That long-term target was something the bulls could hang their hat on.
Now it’s gone. And so are some of KR’s investors.
But there may be an opportunity in this rubble. Here’s why.
Kroger Has Many Advantages
Kroger is cheap and big. Those advantages are currently being undervalued by the market.
In today’s commerce world, price and convenience rule with an iron fist. Consumers differentiate their shopping options by how expensive they are and how convenient they are (or how close they are).
Kroger is cheap. Even after the huge price cuts, Whole Foods is still extremely expensive. It’s far more expensive than Walmart, Target and Kroger. In this sense, even though price cuts are coming across the entire industry, Kroger remains in the low price cohort.
That’s good, because consumers are always looking for low prices.
Kroger is also really, really big. Kroger operates roughly 2,800 stores across 35 states. That is extremely dense (by comparison, Whole Foods operates 465 stores across 3 countries). It’s so dense that it means a Kroger grocery store is likely very close to you. According to Chief Financial Officer Mike Schlotman, most customers live within a mile and a half of a Kroger grocery store.
That’s also good, because there really isn’t much stickiness in grocery shopping. You often just go to the one closest to you.
Moreover, Kroger is particularly immune to Whole Foods price cuts because the nation’s largest grocery store offers different stuff than Whole Foods. You can’t buy a bag of Ruffles or Lay’s chips at Whole Foods, but they are all over Ralph’s and Dillon’s grocery stores.
In fact, there is a whole list of ingredients that Whole Foods considers “unacceptable.” As long as WFM keeps this motto, Kroger will have a product moat against Whole Foods.
Bottom Line on KR Stock
So why will Kroger all the sudden lose customers en masse? They won’t.
Kroger grocery stores are cheap, close and particularly immune to Whole Foods price cuts because of differences in product offerings.
Yes, it’s troubling that management has ditched its long-term 8-11% earnings growth target, but KR stock isn’t priced for much growth anyway. Earnings this year will likely come in around $1.90 (after hurricane effects are factored in). That means KR stock is trading at 11-times fiscal 2017 earnings estimates.
The S&P 500 trades at almost 19-times 2017 earnings estimates.
KR stock is simply too cheap here to ignore. If you want to draw out the mall-retail analogy, KR stock is being valued like a big department store. It’s cheaper than Nordstrom, Inc. (NYSE:JWN), which trades at 15.5-times this year’s earnings estimates, and it trades in line with Kohl’s Corporation (NYSE:KSS), which also trades around 11-times this year’s earnings estimates.
But Kroger’s comparable sales growth is currently positive, and expected to remain positive for the balance of the year.
Kroger isn’t a department store. So KR stock shouldn’t be valued as one. I’m using this dip as opportunity to buy the stock.
As of this writing, Luke Lango was long KR, KSS, TGT, and AMZN.
